Many builders tie their incentives to the use of the builder’s lender and title company. On the outside, you may think it’s no big deal. The builder just wants to make a few extra bucks on the back-end while you get tens of thousands off of the price of the home.
But let’s dig deeper…
Let’s say you’re looking around for resale (non-new construction) single-family homes and you really like a few homes you saw in the $600K to $650K range. But, after speaking with your lender and seeing how they crunched the numbers, you see that the top end of your approval amount and comfort price range is $550K (based on a 30-year fixed-rate mortgage at 4.75 percent at 1 point).
What do you do?
You adjust your search to properties priced no more than $550K and continue your search. Once you find a property you like, your agent does a market analysis and determines that the property is over-priced by $40K. Despite you really wanting the property, there’s no way you’re going to overpay for a property so you either offer them less or keep on looking for other properties.
Now let’s say that you fall in love with a new construction single-family home priced at $650K.
You contact the builder’s lender, fill out and application and let them crunch their numbers. As the lender crunches the number, they come to the same conclusion – you’re really only approved up to $550K.
But the lender knows that the builder doesn’t have any lower priced single-family homes available. If the lender tells you that you can’t afford to buy that house, you may go to another community and another builder. If the other builder’s lender somehow finds a way to approve you up to $650K, you may buy a single family home in the other builder’s community. That means the builder and the builder’s lender will lose a home sale AND the money from your loan AND the money you’ll pay the builder’s title company at closing.
What does the lender do?
Many times, they find a way to get you approved up to $650K – even if that means that it’s not in your best interest.Here’s how the two scenarios differ:
In the first scenario, your interests are being looked out for by various people, none of whom are anxious for you to buy any specific property. You don’t get stuck in a loan you can’t afford to pay and you don’t overpay for a home.
In the second scenario, no one is looking out for your best interests. The builder, the builder’s lender and the title company are all tied together and looking out for each other’s best interest and pocket book – not yours. They want to make a sale and get you to pay the most possible for the home. It would be a conflict of interest for the builder to look out for your best interests because it would mean that their sales and profits would go down.
(And do you think that the builder’s sales rep/manager is going to tell you that the home is overpriced? HA! Yeah, right…)
Moral of the story…
Make sure you understand that builders, their sales rep/manager, their affiliated lender and title company are only looking out for one thing – their own best interests. They’re not there to make sure you don’t get in over your head nor that you get a good deal. If you don’t believe me, check out this real life example.
Slightly off-topic, but very relevant…
This is why the current battle by HUD to pass new RESPA laws banning builders from tying incentives to the use of their affiliated lenders needs to be won by HUD. The new law was passed and was supposed to go into effect on January 16, but its been put on hold, probably because of the law suit by the National Association of Home Builders (NAHB) who knows that it would cut into their bottom line regardless of the good it would do home buyers.
Last month, HUD passed a new law banning home builders from tying their incentives to the use of an affiliated lender (and for good reason – post about this to follow soon). This law is part of HUD's RESPA reform and was supposed to go into effect January 16. Unfortunately, HUD has delayed putting that law into effect.
One reason may be that the National Association of Home Builders (NAHB) is suing HUD in an attempt to block that law from passing. If the law passes, builders will lose revenue generated by their affiliated lender businesses so they have quite a lot at stake.
HUD has agreed to delay implementation of the law by 90 days (as of earlier this month). As I hear more, I'll keep you posted.
If you've ever bought a new construction home from a builder in Loudoun County (or anywhere else for that matter), you've probably heard the phrase,
"Our incentives are tied to the use of (fill in the blank) mortgage company and (fill in the blank) title company. You don't have to use our lender or title company, but you'll forfeit the incentives being offered if you don't."
Builders have long been able to get away with this practice. They operated within current RESPA regulations which state that home buyers have the right to choose whichever lender and title company they wish. Since the builder is not forcing you to use their lender or title company, they weren't in violation of those regulations. And their tying the incentives to doing so didn't violate them either.
But that may be changing. The practice of tying incentives to lenders has come under fire and there are reports that there is serious talk of new RESPA regulations that will ban builders from tying incentives to the use of lenders which they have a financial stake in. (This may also spill over to the use of title companies which builders have financial stakes in)
I'm all for this. As it stands now, builder's lenders and title companies generally have higher fees and closing costs than "retail" lenders and many other title companies. But the incentives tied to use of the builder's lender and title company outweighs the higher costs associated with using them so it's still better for buyers to go with the builder's lender and title company.
If the change happens, buyers will be able to take advantage of the incentives as well as get a better deal on closing costs and fees. And it will promote more competition, which is better for consumers.
But then again…if the changes to RESPA do happen, the builders may all scale back their incentives to make up for the lost revenue from their mortgage and title companies.
There's more to come on this in the near future…I'll keep you posted.